U.S. Foreign Economic Policy After September 11th

Barry Eichengreen

Unquestionably, the events of September 11th have reshaped the debate over globalization. A trend that many economists characterized as irresistible suddenly appears less so. Foreign assembly operations have become less attractive to U.S. corporations now that there is the fact, or even the danger, that their trucks will be stuck in mile-long queues at the U.S.-Canada or U.S.-Mexico border. Companies like McDonald’s and Starbucks, whose main opportunities for market growth are outside the United States, now must factor in extra costs of security when contemplating opening another outlet abroad. Computer programmers from India and graduate students from Pakistan will face additional hurdles when attempting to obtain temporary residency in the United States, and American companies will think twice about posting their executives abroad. Foreign trade, foreign direct investment, and international migration all will grow less quickly than they did before the terrorist attacks.

All this is common sense. But it is also common sense not to push the argument too far. For one thing, there will be a strong incentive to invest in new technologies that will minimize disruptions to international business. We already use infrared scanners on certain trucks coming in from Mexico and CAT scans on selected luggage at airports. More investment in such equipment will allow international traffic to move more quickly, whether that traffic takes the form of trucks, container ships, or passenger airliners. Technologies that are hard to imagine now, precisely because they have not been invented yet, will help to move these lines even faster. The 60 per cent rise in the prices of the stocks of security-related companies in the four weeks following September 11th confirms that the incentive for their development is there.

International cooperation will work in the same direction. Vincente Fox has already proposed major investments in immigration control on Mexico’ southern border, which will limit the burden on U.S. immigration officials along the United States’ own southern border. A survey of 250 Canadian CEO’s, taken at the end of October, similarly yielded an overwhelming consensus that the two neighbors should urgently agree on a common set of rules immigration in order to protect Canadian access to the U.S. market. Our NAFTA partners have the largest investments in globalization of virtually any countries in the world. They have a strong incentive to make us see the relevant security zone as North America and not simply the United States.

The terrorists targeted the World Trade Center because it was a symbol of American capitalism in one of its most visible manifestations, American financial markets. Among the victims were large number of persons who worked for companies, foreign as well as domestic, whose business was international finance. This points up the question of how international capital flows will be affected by these events. Clearly, bonds issued by countries that are on the front lines of the so-called war against terrorism, Pakistan for example, will be regarded as even riskier than before. But there are plausible reasons for thinking that disembodied portfolio investment, as opposed to direct investment, will be stimulated rather than depressed by the attacks. Buying a bond of a foreign government or a stock issued by a foreign corporation is physically less risky than opening an American factory abroad or checking into the Intercontinental Hotel in the capital city of a country whose government is not a member of the Bush Administration’s coalition against terrorism. There is still a big world economy out there. Investors still want “foreign exposure” in their internationally-diversified portfolios. Arguably, portfolio investment will be even more attractive than before as a way of getting it.

The main impact on capital flows thus will be not on their level but on their composition and direction. Investors will have an even stronger incentive to differentiate among countries according to the strength of their economic, financial, and political institutions. One of the problems of the 1990s was that investors, in their enthusiasm for emerging markets, failed to differentiate adequately among destinations for their funds. Any new tendency for capital to flow more disproportionately to countries that have built relatively strong financial systems, political institutions and international alliances can only be a good thing from the point of view of financial stability. This will also sharpen the rewards for countries that build strong democratic institutions, that deal with minorities in ways that minimize ethnic strife, and that build bridges to their neighbors, since these will be the places where Americans will seek to invest. Of course, this also means that the gap between the haves and have-nots will widen. More foreign investment will flow to the first-tier countries of Eastern Europe, attracted by their democratic institutions and prospects for EU accession. Investment in sub-Saharan Africa, in contrast, is likely to be seen as even less attractive than before.

This new emphasis on politics, international politics in particular, means that investors will be paying special attention to the implications of recent events for International Monetary Fund assistance for emerging markets. The Bush Administration has made clear that it will use every weapon at its disposal in the fight against terrorism. The IMF is one such instrument, like it or not, since the United States is the Fund’s largest single shareholder. This clearly enhances the prospects for multilateral assistance for front-line countries like Turkey, who are now too geopolitically important to be allowed to default on their debts.

Argentina, on the other hand, is far from the front lines. (One is reminded of Henry Kissinger’s quip that “Argentina is a dagger pointed straight at the heart of Antarctica.”) Now that the stakes have been raised, amplifying the voices of those who argue that we cannot afford a major disruption to international financial markets, IMF lending will be ramped up. But to demonstrate that the United States is not consorting with the IMF in blindly throwing at emerging markets the hard-earned tax dollars of U.S. plumbers and carpenters (to paraphrase Treasury Secretary O’Neill), there will also be a temptation to make an example of a problem country. It is not hard to imagine who this might be.

Just as the Asian crisis ultimately forced the Congress to acknowledge the need for an IMF quota increase, the current crisis highlights the need for the international financial equivalent of the FDNY. Thus, the extreme view on Capitol Hill that the IMF should be abolished is likely to be extinguished once and for all. On the other hand, the legitimacy of the IMF and its economic advice will not be enhanced if it is viewed by other countries, even more than before, as an instrument of U.S. foreign policy. Calls for reform of the institution’s voting formulas and procedures to enhance the representation of developing countries are likely to be met in Washington by the response “not now.” If the IMF becomes less of a politically lightening pole here, the opposite is sure to be true in the developing world.

This new enthusiasm for IMF programs will be only one manifestation of a more outward-looking U.S. foreign economic policy. Clearly, it will be easier for the Bush Administration to make the case for Fast-Track Authority to reward friendly countries with enhanced access to the U.S. market. It will push harder for debt relief for highly-indebted poor countries in the hope that less debt will mean more growth, and more growth will mean fewer disaffected religious fundamentalists. Progress in granting debt relief has been slowed by the perception, not entirely accurate, that it has budgetary costs for the OECD governments that are the principal creditors, and that blanket relief would penalize countries that had made serious efforts to reform while rewarding spendthrift governments. These objections are likely to be shelved as a result of the new urgency attached to enhancing stability and restarting growth in the poorest countries.

What of foreign aid? Talk of a “Marshall Plan for Afghanistan” has already started. It will be followed by arguments that the United States cannot continue giving only pitiful amounts of aid to countries where young men seek refuge from grinding poverty and lack of opportunity in political and religious fanaticism. Some increase in U.S. foreign aid there will surely be. The Marshall Plan was most directly motivated by the eruption of the Cold War; some kind of “New Marshall Plan,” it can be confidently predicted, will be proposed by the Administration in response to the war on terrorism, although whether the U.S. will be prepared to devote two per cent of its GNP over four years to such an initiative, as it did between 1948 and 1951, is another question.

The answer lies, in part, on what return we can expect on our investment. The Marshall Plan may have been a great economic and political success, but a reading of its history, and the history of foreign aid generally, renders one pessimistic that its success can be replicated in many of the poorest countries today. Foreign aid has worked only where there has existed a domestic constituency for reform and where multilateral assistance tipped the balance in its direction. This was recognized by one of the IMF’s early managing directors, Per Jacobsson, as early as 1959, when he observed that foreign assistance “can only succeed if there is the will in the countries themselves.” Why, then, did Marshall Plan funds work after World War II to help bring about inflation stabilization, fiscal consolidation, and market-friendly reform? The answer is that European governments were strongly predisposed to adopt these policies, and the Marshall Plan tipped the balance by limiting the short-run pain and sacrifices that had to be imposed on their constituents. Europe already had long experience with the market, which inclined it toward the adoption of market-friendly reforms. It had suffered devastating hyperinflations after World War I, which predisposed it to monetary and fiscal stabilization after World War II. It had democratic governments with checks and balances that prevented aid from being diverted into the pockets of elites. And many European countries had single-party governments or strong coalitions capable of credibly committing to the relevant reforms.

Where on the other hand has foreign aid not worked? It has not worked where there did not already exist a strong domestic constituency for reform, where the government was weak, and where democracy was absent or the government otherwise lacked the capacity to commit to the relevant reforms. Thus, scholars like Andrew MacIntyre ascribe the failure of IMF assistance to produce quick results in Thailand in 1997-8 to a flawed constitutional design that generated weak coalition governments and incohesive parties unable to commit to reform. They attribute the severity of Indonesia’s crisis to the weakness of democratic institutions, which vested arbitrary decision making power in the hands of one person, Suharto, who could as easily change his mind as stay the reformist course.

These historical observations caution against exaggerated hopes that foreign aid conditioned on a laundry list of reforms and policies can play a major role in getting a postwar Afghanistan back onto its economic feet. They suggest relatively pessimistic conclusions about whether providing sustained U.S. aid, as opposed to dropping dehydrated meals from the skies and hiring U.S. construction companies to rebuild bridges and airstrips, will do much to alleviate the problems of countries where contract enforcement and investor protections are unreliable, and where political checks and balances are too weak to prevent foreign aid from being funneled into the pockets of the elites. We have no choice but to try, but realism and the historical record suggest not expecting too much of foreign aid to countries that have not yet succeeded in putting the relevant political and economic infrastructure in place.

We know much more about how to help developing countries that have already begun to take these steps. Abolishing restrictions on their sales of bananas to Europe and apparel to the United States can invigorate their exports, raise their rates of economic growth, and help to create improved living standards for their masses. 1 The Multifiber Agreement, an historical anachronism dating from 1974, continues to limit imports of textiles and apparel into the U.S. market. If the Congress is serious about addressing the problems of developing countries as a way of bringing them into the fold, it could start by abolishing the Multifiber Agreement. U.S. foreign economic policy cannot solve the problems of the entire world. Some parts will have to first begin to help themselves. But where they have done so, and where we have instruments that can usefully push the process along, it would be a crime not to do so.

November 1, 2001

Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley, and a member of the Board of Directors of the SSRC.

The idea that freer trade and improved market access for developing countries can help to improve the prospects of the vast majority of their poorest residents is such obvious common sense that it almost inevitably becomes the subject of arcane academic debate and controversy, requiring a footnote. Evidence as opposed to rhetoric speaks clearly: see Neil McCullock, L. Ana Winters and Xavier Cirera, “Trade Liberalization and Poverty: A Handbook,” London: Centre for Economic Policy Research (2001). ↩

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About the 2001 Essay Archive

This is a reformatted post from the SSRC's original After September 11 essay forum, launched in October of 2001. To view the original forum, which carries additional resources, such as a teacher's guide and helpful, though in many cases outdated, links to online material, please visit that archival site at http://essays.ssrc.org/sept11/archive/.